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FDI AND PPP IN INDIAN DEFENCE SECTOR

(A PERCEPTION BASED ANALYSIS)

Dr.Samir Kumar1, Dr.Sandeep Nath Modi

2

1Sr.Manager, Syndicate Bank, Faculty at National Institute of Financial Management,

Ministry of Finance, Government of India, Faridabad, Haryana (India)

2Manager, Syndicate Bank, Faculty at National Institute of Financial Management,

Ministry of Finance, Government of India, Faridabad, Haryana (India)

ABSTRACT

India is the largest arms importer in the world. During the last five years India imported almost 15per cent of

the volume of global arms more than three times as much as China.India needs to strengthen its R&D and

develop a strong defence industrial base in order to become self-reliant in the field of Defence. Govt. recently

eased FDI norms for Defence, by enhancing the limit from 26% to 49%. In order to be self-sustainable, 100%

PPP is allowed in defence. The Defence Procurement Manual has been amended from time to time in order to

take into stride the wave of globalisation and liberalisation. However, despite all this, India still stands at a

point where it must take flight over the globe on its wings of modernisation and a strong industrial base. India

has to make its dream of being self-reliant in Defence a reality. The Present study has been divided into two

sections. Section -1 helps us to understand the Indian defence environment and the macro variables affecting

PPP and FDI in terms of Opportunities, Threats, Weakness and Strengths. Section -2 of this study analyses

the factors influencing the requirementof Public Private Participation and FDI in Indian Defence Sector.

Keywords: Foreign Direct Investment, Public Private Partnership, Defence, Research and

Development , JEL Classification: E61, R42, O33, N40

I. BACKDROP

India has a large infrastructure for furthering its defence production capabilities. But it is yet to grow and build

on this potential. In the mid-1990s, the country decided that it would not depend on outside world for defence

related equipment and hence, India had to turn to other countries to help it meet its defence related equipment.

Indian military stakeholders and the government have started to re-assess the need of revamp of the present

approach of defence Industry.

1.1 Overview of Indian Defence Sector

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India‟s security environment is complex. It is an intricate interplay of regional and global challenges. The

country being strategically located, needs to be prepared to counter the various impacts likely to be caused by

the regional and global forces and hostile neighbourhood.

Considering the neighbourhood and India‟s continuously growing economy, we require a robust defence

industry which in turn would depend on the robust defence strategy and Government policies. The aim of the

nation is to deter the wide spectrum of all types of security threats faced by our country today. India‟s role and

location is not only restricted to its immediate neighbours, but also in middle East, South Eastern Asia and

Indian Ocean Regional countries. The Global security scenario is no longer just a conventional war but non

state actors have made the threat more volatile and uncertain.

1.2 Organisation Structure of Ministry of Defence

The primary task of the Ministry is to formulate policy on defence and security related matters and communicate

the same to the Services Headquarters, within the service Organisations (ISOs), Production facilities and R&D

Organisations. The main functions of the Departments are as under:-

I The Department of Defence handles the Integrated Defence Staff (IDS) and three Services (Army, Navy and

Air Force) and various Inter Service Organisations. It is mainly responsible for the making policies related to

Defence and establishment matters, Defence Budget, Parliament related matters and defence co-operation with

foreign countries etc.

II The Department of Defence Production as the name suggests deals with the matters related to the defence

material production and is headed by a secretary level officer.

III The Department of Defence Research and Development is the department which looks after the research

and development of Defence equipment and spares required for the security of the nation.

IV The Department of Ex-Servicemen Welfare handles the issues and matters related to all welfare, their

resettlement and pension of Ex-Servicemen.

1.3 Defence Production in Public Sector

The Defence Production department deals with for the defence production units which is a well-developed

infrastructure comprising of 39 Ordnance Factories and 08 Defence Public Sector Undertakings

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(DPSUs).DPSUs are involved in the production of aircraft and helicopters, submarines, warships, heavy

vehicles, earthmovers, and missiles. Presently, there are 41 Ordnance factories in India spread all the country.

1.4Make in India Initiative by Government of India

In order to make India an international manufacturing hub, which is a tall order at this point of time for the

country, the Government of India has launched an initiative called „Make in India‟ which is a political slogan

encompassing encouragement of FDI in India and making business easier i.e. facilitating 'ease of doing business'

in the country. All this is being done to improve the country‟s economy in a longer run. Make in India aims to

increase manufacturing growth rate to 10% by changing the unnecessary laws, assisting in easier bureaucratic

processes, transparency and accountability.

1.5 „Make In India‟ Policy forthe Defence Sector

As Defence sector depends heavily on imports, Make in India can bring about a balance in imported and

indigenized equipment without affecting the requirements of the services. There are different scenarios in which

India can do it. First, we should be able to design, develop and make i.e. manufacture, test, maintain and

upgrade on our own. We should be able to take along the private sector and create synergy amongst the

industry, Govt and R&D. The best case would be if we can export these equipment.

The second best scenario would be to at least manufacture or integrate the system within the country with the

help of full technology transfer. This situation is not prevalent as of now in India. In such cases, if we are not

able to do mid-life up gradation, then at least we should be able to provide a life cycle support.

1.6 Indian Defence Sector and the Acquisition policies.

In order to holistically understand the impact of FDI, PPP or Make in India initiative, it is important to mention

about the defence sector, its various stake holders, their perspectives and the Defence Ministry policies for

Defence acquisition.

Defence Acquisition is decision-making process which meets the requirements of procurement, indigenous

defence production and higher transparency and accountability. The Defence Procurement Manual 2013, is

the main policy document which describes the terms and procedures for defence acquisition in India. Over the

years, considerable changes have taken place from the „Buy‟ cases to „Buy and Make through Transfer of

Technology‟, basically promoting „Buy and Make (Indian)‟. The idea is to promote Indian defence industry

with the involvement of private players initially and subsequently shifting to the „Buy (Indian)‟, „Buy and Make

(Indian)‟ and „Make‟ categorisation.

II. OBJECTIVE OF THE PRESENT STUDY

i. To analyse the Indian defence sector and study the macro variables affecting PPP and FDI in terms of

Opportunities, Threats, Weakness, Strengths.

ii.To examine the Factors influencing the requirement of Foreign Direct Investment and PPPon Defence

production in India.

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III. SCOPE OF THE STUDY

The scope of the study is limited to:-

i. Indian Defence sector

ii. Secondary data available on websites, journal, books, newspapers and Reports of Government and Industry

bodies. Only open source data available for last five years covering period 2011-2015 will be analyzed

iii. Primary data has been collectedfrom 125 Govt officers serving in Defence Sector for the perception based

analysis.

IV. STATISTICAL TREATMENT FOR DATA

Responses to the questionnaire have been statistically analysed keeping the objective in mind. Factor Analysis

with the help of SPSS has been used to know the factors influencing the PPPand FDI in defence sector. Twenty

Questions based on different attributes had been asked from 125 respondent.

V. LIMITATIONS OF STUDY

The limitations of the study are as follows:-

i. No Previous Detailed Research Work.

ii. Access toData: The subject matter is the defence sector, therefore, the restriction of access to data is there.

Only unclassified data and information available on open forums can be used.

iii. Time constraint. Due to constraint of time available for project, researcher cannot go too much into details

of subject

VI. REVIEW OF LITERATURE

Kaushal (December, 2014) in his article about need of Public Private Partnership in the Defence Aviation

Industry in India has brought out the various facets of Defence production. His article aims at bringing out

reasons as to why Indian aviation industry depends heavily on imports, despite the fact that Defence PSUs like

HAL are there. It has been recommended by the author that taking strategy based decisions instead of project

based decisions, preparing a long term plan for technology acquisition and mid-life upgradation and harnessing

public private partnership is the way forward.

Kaur(2013) in her paper brings out various facets of Defence Industrial base in India and the role of PPP in

making India self-reliant. While the Defence Procurement Procedure (DPP) 2013 emphasizes on indigenous

development. Last few decades have seen Indian private sector growing exponentially. Its growth trajectory had

been steep and the capacity to innovate and develop world class solutions in various technologies had been

immense. In India, PPP model has worked well in building large and complex infrastructure projects like roads

highways, airports etc. The same approach can be adapted in Defence research and development and

production.

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Dr Vijay Kelkar Committee Report (April 2005) identified the potential of private sector and the positive

opportunities and possibilities that could happen if PPP model is implemented in Defence Sector. The Paper

concludes that significant factors like fair play for competitors, Public Private Partnerships, foreign Joint

Ventures can catalyse defence manufacturing and given necessary impetus to innovation and dynamism. The

author has expressed appreciation for the Government efforts to make the system more transparent and

streamlined. However, he opines that the private sector should be provided level playing field with DPSUs.

VII. POPULATION AND SAMPLE OF THE STUDY

Random sampling is used to select officers from different services (Army, Air force, Navy) holding different

ranks and different levels of experience.

VIII. RESEARCH DESIGN

The Research design used is that descriptive research. This type has been used because the population to be

studied is the officers of Government of India, especially those working in defence sector. This has been found

to be the ideal design when studying the population as in this research. Two methods under descriptive studies

have been used which are:

i. Questionnaire

ii. Interview

8.1 Research Instrument Used

The instrument for collecting primary data used has been Questionnaire. The questionnaire has been drafted

based on the researcher‟s own experience and understanding of the subject and various defence related literature

published in journals and online.

Section-1

8.2 The Indian Defence Environment Analysis

The analysis of impact of FDI in Defense sector is a tricky affair. First because it is a newly increased cap and

the effect of increased limit to 49% in Defense sector is yet to show its impact. And second because Defence

sector in India is a complex and specialized field in which any private and more so a foreign party cannot

venture. Obviously, the deterrence are in place for a private player to participate in production of Defence

equipment in the country. Interestingly, not the Indian but the foreign firms are a big part of Indian Defence

sector, as India heavily relies on imported arms and equipment like never before. The figure -1 given below

suggests us that India is the largest importer (14%) of weapons.

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Figure 1: World's largest Importers and Exporters of Arms (2011-2015)

The table-1 given below suggests us that India has secured 6the rank regarding military expenditure in the year

2015

Table 1: Countries with highest Military

Expenditure

(Source: Stockholm International Peace Research Institute 2016)

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The table no -2 given below makes SWOT analysis of Indian Defence Sector

Table -2:SWOT Analysis of IndianDefence Sector

STRENGTHS

Huge Demand

Adequate Manufacturing infrastructure

Sufficient R&D facilities

Large pool of scientists, engineers and skilled

manpower

WEAKNESSES

Huge import

Lack of indigenization

Minimal absorption of Technology

Inability to retain talented scientists

Unfavorable policies like FDI and Taxation

OPPORTUNITIES

Reduction in Defence budgets in USA and Europe

Domestic industry can be benefitted

Private sector participation

Increased FDI limit to 49%

Make in India Initiative

New Defence Procurement Procedure-2016

THREATS

Over dependence on foreign companies may lead to

sanction by Foreign Governments

Untrustable neighborhood viz Pakistan, China

Adversaries (Pakistan)investing heavily in acquisition and

development of defence equipment

Indigenization of defence equipment though reverse

engineering by China

Increasing clout and military power of China

8.3 Where to Restrict the FDI inDefence:

For the Defence sector, the FDI has been increased to 49% from26% which hardly attracted any FDI in the

previous years. FDI more than 49% can be allowed on case-to-case basis. Apart from easing FDI norms, the

present Government is taking steps to make doing business in India a procedurally easy affair. But there is still a

sense of discontentment in the private sector and foreign investors on the issue of cap of 49% FDI in Defence

sector in India.

There are mainly two reasons why increase in FDI in Defence is being opposed by some sectors in Government.

One, that it hampers the security environment in the country. There is this fear that the national security will be

compromised when defence Ministry shares what all they need and in what quantity, there by exposing the

strategic requirements and plans of armed forces. .

Secondly, there is a protectionist quarter in the Government, who would not like the monopoly of the

Government machinery to go. It is a presumption by some that opening defence sector to foreign investment

would hamper the interests of private Indian companies. This would disturb an already fragile environment of

defence industrial base in India.

8.4 The Economics of Public Private Participation

If India is to attain self-reliance in the defence industry, better infrastructure is needed to build, sustain and

improve upon the present capabilities. The government therefore is looking to Public-Private sector partnerships

to meet this challenge. There is a understanding that the private sector is better at some aspects like handling

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certain risks, and on the other hand the public sector can handles some other issues bettersome others.The

private sector is better in reducing the construction cost and time over runs, thereby achieving good operational

efficiency and maintenance. On the other hand, the public sector is better placed in taking a longer term view of

the benefits of projects particularly when they involve costs that flow to the larger society such as lower

transport costs enabling producers to realise higher margins.

8.5 Summary of the Analysis:

1. To reduce license regime and boost indigenous industrial capabilities. Success of this kind will not only

validate India‟s defense-industrial capabilities to meet domestic demands but also increase its confidence in

many ways.

2. Second, the recent opening up of the defence sector for private participation has generated a lot of interest

in the country. Fears regarding the ability of the private sector to match expectations of the country in the

highly demanding and technology-dominated industrial sector are countered by industrialists.

3. The simplification of production and procurement rules promise better buyer-seller relations. Significant

diversification and closer private participation are significantly influencing India‟s defence industry in

many ways.

4. Fourth, the encouragement provided by the government is driving the defence industry to have more joint-

design, development and production collaborations to reduce dependence on imports.

5. Fifth, the Government's export-related incentives, including subsidies, to the industry is a significant result

oriented strategy. India has been spending roughly US $0.5 billion on an average annually for the last five

years. This is likely to go up to US $1 billion in the next decade. However, the current and future

production may eventually take India close to the desired level of self-reliance.

Section -2

8.6 FDI and PPP in Indian Defence Sector (A Perception Based Analysis)

The section 2 of the present study is a Perception based analysis regarding the requirement of FDI and PPP in

Indian Defence Sector. For this purpose twenty questions, based on different attributes had been asked from 125

defence officers of Indian government. The output of factorial analysis in SPSS has been explained below –

8.7 Output of the Factor Analysis:

Table -3 given below highlights the descriptive statistics of various attributes

Table – 3 :Descriptive Statistics

Mean Std.

Deviation

Analysis N

Permission for FDI 2.1774 1.19653 124

Role of DRDO not up to mark 2.1613 1.23227 124

Own industrial base using PPP 1.5000 .70423 124

Vagueness of PPP model in Defence 3.0887 .90178 124

Liberalisation for Ease of Doing Business 2.0161 .76492 124

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Self-Reliance in Defence Sector 1.7500 .73942 124

Insufficiency in Defence Production 2.4194 1.30725 124

Insufficiency of Defence Budget 3.0484 1.28059 124

Constraint of 26% FDI limit 2.4032 .98707 124

Confidential nature of work as deterrence in PPP 2.9194 1.20025 124

FDI limit more than 49% 2.3871 1.14558 124

High Upgradation cost 2.2177 .95900 124

Liberalised Defence Production Policies 2.2016 1.21628 124

Insuffiency of 49% FDI limit 3.0565 1.17080 124

Make in India for cost minimisation 2.1613 .91409 124

Make in India for economic growth 1.6694 .79349 124

Unsatisfactory performance of DPSUs 2.0323 .94512 124

Promoting Defence Production through PPP 2.2419 .89598 124

Requirement of skilled manpower 2.7661 1.16945 124

Security threats with FDI more than 49% 3.0161 1.28774 124

8.8 Communalities

The next item from the output is a table of communalities which shows how much of the variance (i.e. the

communality value which should be more than 0.5 to be considered for further analysis. Else these variables are

to be removed from further steps factor analysis) in the variables has been accounted for by the extracted

factors. The table no 4 given below shows us the communalities of the respective attributes based on the

Principal Component Analysis

Table -4: Communality

Initial Extraction

Permission for FDI 1.000 .701

Role of DRDO not up to mark 1.000 .652

Own industrial base using PPP 1.000 .660

Vagueness of PPP model in Defence 1.000 .514

Liberalisation for Ease of Doing Business 1.000 .570

Self-Reliance in Defence Sector 1.000 .717

Insufficiency in Defence Production 1.000 .694

Insufficiency of Defence Budget 1.000 .723

Constraint of 26% FDI limit 1.000 .683

Confidential nature of work as deterrence in PPP 1.000 .607

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FDI limit more than 49% 1.000 .734

High Upgradation cost 1.000 .589

Liberalised Defence Production Policies 1.000 .723

Insuffiency of 49% FDI limit 1.000 .653

Make in India for cost minimisation 1.000 .790

Make in India for economic growth 1.000 .629

Unsatisfactory performance of DPSUs 1.000 .750

Promoting Defence Production through PPP 1.000 .659

Requirement of skilled manpower 1.000 .590

Security threats with FDI more than 49% 1.000 .643

Extraction Method: Principal Component Analysis.

IX. TOTAL VARIANCE EXPLAINED

The table no. 5 givenbelow shows us the actual factors that were extracted. If we look at the section

labelled “Rotation Sums of Squared Loadings,” it shows us only those factors that met our cut-off

Criterion (extraction method).In this case, there were seven factorswith eigenvalues greater than 1. SPSS

always extracts as many factors initially as there are variables in the dataset, but the rest of these didn‟t

make the grade. The “% of variance” column tells us how much of the total variability (in all of the

variables together) can be accounted for by each of these summary scales or factors. Factor 1 accounts

for 15.838% of the variability in all 20variables, and so on. Thus the seven factors identified explain

66.39 % variance.

Table No -5 : Total Variance Explained

Compon

ent

Initial Eigenvalues Extraction Sums of Squared

Loadings

Rotation Sums of Squared

Loadings

Total % of

Variance

Cumulativ

e %

Total % of

Variance

Cumulativ

e %

Total % of

Variance

Cumulativ

e %

1 3.891 19.454 19.454 3.891 19.454 19.454 3.168 15.838 15.838

2 2.325 11.626 31.080 2.325 11.626 31.080 1.966 9.829 25.668

3 1.865 9.323 40.403 1.865 9.323 40.403 1.854 9.271 34.939

4 1.646 8.228 48.632 1.646 8.228 48.632 1.689 8.443 43.382

5 1.284 6.418 55.050 1.284 6.418 55.050 1.594 7.968 51.350

6 1.171 5.857 60.906 1.171 5.857 60.906 1.569 7.845 59.195

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X. SCREE PLOT

The scree plot is a graph of the eigenvalues against all the factors. The graph is useful for determining how

many factors to retain. The point of interest is where the curve starts to flatten. It can be seen that the curve

begins to flatten between factors 7 and 8. Note also that factor 7 onwards have an eigenvalue of less than 1, so

only 7 factors have been retained.

Figure No-3: ScreePlot

7 1.098 5.490 66.396 1.098 5.490 66.396 1.440 7.201 66.396

8 .917 4.586 70.982

9 .797 3.984 74.966

10 .711 3.554 78.520

11 .669 3.343 81.863

12 .551 2.753 84.616

13 .539 2.696 87.312 .

14 .491 2.454 89.766

15 .442 2.209 91.975

16 .420 2.100 94.075

17 .346 1.728 95.802

18 .305 1.524 97.326

19 .275 1.373 98.699

20 .260 1.301 100.000

Extraction Method: Principal Component Analysis.

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XI. ROTATED FACTOR LOADING

A summary of the exploratory factorial analysis of requirement of PPP and FDI in defense sector is given in the

Table No –3: Summary of the Exploratory Factorial Analysis of requirement of PPP and FDI in defense sector

of India.

Rotated Factor Loading

Overcomi

ng

Research

and

Productio

n

inefficienc

ies

Securit

y

concer

n with

enhanc

ed FDI

limit

Cap on

FDI

limit

Promotin

g Make in

India

Insufficient

Defence

Budget

Enhanceme

nt in

present FDI

limit

High up

gradation

cost

Permission for FDI .787 .181 .056 .095 .172 -.021 -.087

Own industrial base using PPP .086 .337 .177 .674 .169 -.120 -.049

Permission for FDI .653 -.110 -.076 .157 .296 -.112 -.300

Role of DRDO not up to mark .036 .424 .405 .049 .254 .159 .276

Own industrial base using PPP -.121 .145 -.006 -.044 -.087 .722 .064

Vagueness of PPP model in Defence .036 .824 -.059 -.019 -.059 .030 .168

Liberalisation for Ease of Doing Business .431 .539 -.112 -.029 .219 .203 -.340

Self-Reliance in Defence Sector -.185 .070 .060 .030 -.106 .070 .814

Insufficiency in Defence Production -.436 .347 -.045 .076 .440 .360 -.203

Insufficiency of Defence Budget .219 .202 -.530 -.099 .072 .466 -.071

Constraint of 26% FDI limit -.018 -.016 .842 .011 -.023 .102 .115

Confidential nature of work as deterrence

in PPP .739 .126 -.070 .038 -.106 -.088 -.044

FDI limit more than 49% .447 -.147 -.008 .076 .429 .486 .274

High Upgradation cost .490 .072 .337 -.346 -.087 .217 -.345

Liberalised Defence Production Policies -.003 -.276 .117 .634 -.232 .422 -.258

Insuffiency of 49% FDI limit .202 -.130 -.042 .735 .007 -.065 .158

Make in India for cost minimisation .217 -.015 .120 .009 .818 -.097 -.098

Make in India for economic growth .425 .558 -.220 -.071 -.203 .183 -.195

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Unsatisfactory performance of DPSUs .611 .075 -.242 .311 .187 .137 .053

Promoting Defence Production through

PPP .106 .135 -.618 -.088 -.334 .237 .236

Eigen Value 3.891 2.325 1.865 1.646 1.284 1.171 1.098

% of Variation 15.838 9.829 9.271 8.443 7.968 7.845 7.201

Cumulative % of Variation 15.838 25.668 34.939 43.382 51.350 59.195 66.396

Extraction Method: Principal Component Analysis.

Rotation Method: Varimax with Kaiser Normalization.

a. Rotation converged in 12 iterations.

Interpretation of the Output

Based on the 20 attributes, 7 factors have been identified to know the impact on FDI and PPP in Indian defence

sector which are as follows:-

Factor 1 : In factor 1, we see that the various attributes like permission for FDI having loading of .780, non-

performance of DRDO having loading .66, insufficiency in defence production having loading .72, promoting

defence production through PPP having loading of .59 and requirement of skilled manpower loading of .67.

Based on the commonality, we can define this factor as “Overcoming Research and Production

inefficiencies” by our subjective approach.

Factor 2: In factor 2, we see that security threat with FDI more than 49% have loading of .66 and no other

attribute have loading of more than .50. So, we define “Security concern with enhanced FDI limit”. It means

while making enhancement in FDI limit, we need to keep in mind the security concern for the country also.

Factor 3: In factor 3, we see that a cap of 26% in FDI limit is having loading of .55 is being viewed as one of

the major causes of low investment by foreign companies in Indian Defence sector. We term it as, “Cap on

FDI limit”.

Factor 4: In factor 4, we observe that focus on Make in India for cost reduction (explained by loading of .55) is

viewed as one of the important factors. Therefore, we may address it as “Promoting Make in India”.

Factor 5: Sufficiency of Defence Budget is being explained by loadingof .44. So, we may take it as another

factor, „‟Insufficient Defence Budget”.

Factor 6: “Enhancement in present FDI limit” having loading of .84 has been viewed as one of the important

factor by the respondents.

Factor 7:“High up gradation cost” having loading of .48 may be taken as another factor for promoting PPP

and enhancement in FDI limit in Defence sector.

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XI. FINDINGS AND SUGGESTIONS:

To sum up it can be inferred from the above analysis that there is a need of FDI and PPP in Indian Defence

sector for overcoming research and production related inefficiencies (Factor 1), and to minimise high up

gradation costs (factor 7). We need to promote Make in India (Factor 4) along with removing cap on FDI limit

(factor 3) keeping in view the security concerns of the country (factor2) with the provision of existing sufficient

budget (factor 5)

REFERENCES

[1] Vinay Kaushal,"The Imperative of Public Private Partnership in the Defence Aviation Industry",

www.idsa.in, Dec 2014.

[2] Karanpreet Kaur,“Defence Industrial Base In India: Public Private Partnership Model”, Centre for

Land And Warfare Studies (CLAWS),www.claws.in, August 2013

[3] www.idsa.in

'Make in India‟ in Defence Sector: An Overview of the Dhirendra Singh Committee Report, 16 Sep

2015

[4] Hindustan Times Newspaper, Article "Sparks Fly in House panel meet on poor defence readiness" 05

April 2016. Ref - Meeting of Parliamentary Committee on Defence.

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in-India.html

a. http://www.outlookindia.com/topic/ppp-public-private-partnership/101167